The decline in inventory also suggests that there are fewer opportunities for buyers and sellers to strike deals. That can further chill sales, as buyers become afraid to overpay while sellers are similarly cautious about underpricing their homes.

The housing market, which has struggled with an oversupply of homes for years, is facing a new problem: a lack of attractive inventory. The number of homes for sale fell for the fourth straight month in September to the lowest level lowest level since began its count in 2007…While falling inventories are typically a sign of health, because reduced competition can boost prices, that isn’t the case right now. Instead, real-estate agents say, people are pulling their homes off the market rather than try to sell them at today’s discounted prices…The shrinking supply isn’t driving up prices because demand is soft. Yet there is still a substantial "shadow" supply of foreclosures and other distressed homes, estimated to be more than one million, that is likely to stream onto the market in the coming years. The pent-up supply is another constraint on any of the price gains that might normally occur when supply falls.
By Nick Timiraos, Oct 17, 2011 WSJ

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Source: House Prices Retreat, Inventories Fall but It’s Still a Difficult Market